As a Canadian business owner or key employee planning for retirement, you are likely wrestling with the question of how to carve-out and protect your hard earned equity from your company without getting eviscerated by taxes.
You are painfully aware of the current low interest rates and high tax rates we face. Central banks are now flirting with zero or even negative interest rates. In Ontario, we face a marginal tax rate of 53.53% beyond $220,000 of income, and eligible dividends are taxed at a punitive 45.30%. With these high marginal tax rates, it makes little sense to pay yourself more than you need to live. The old mantra of “pay yourself first” no longer applies.
Furthermore, limits imposed on HoldCo.’s have restricted their effectiveness as a corporate tax strategy. And IRP’s or “Insured Retirement Plan” strategies have become a lightning-rod for CRA, and have, in many instances, blown up.
So, you are left with a mix of limited, tax advantaged retirement options such as RRSPs, TSFAs, and IPPs/RPPs… all of which suffer from capped contribution and benefit limits.
Fortunately, there is another vehicle that can tip the scales back in your favor. Retirement Compensation Arrangements (RCAs) are like super-sized corporate RRSPs which address pension shortfall concerns for high earners.
Retirement Compensation Arrangements
RCAs fell out of favour in the past due to decreasing corporate and dividend tax rates, and misuse, however they continued to grow in popularity to secure corporate supplemental pension benefits. – Pierre Ghorbanian, CFP, FLMI, manager business development for advanced markets at BMO Life Assurance Company.
Retirement Compensation Arrangements (RCAs) are like super-sized corporate RRSPs which address pension shortfall concerns for high earners.
Today’s rock bottom interest rates and high marginal tax rates make even plain vanilla RCAs an effective tool to save for retirement. See Back to the Future for Retirement Compensation Arrangements | Advisor.ca.
- RCAs are creditor protected Trusts
- funded with pre-tax corporate dollars / contributions which are tax deductible
- no tax to the owner/employee until benefits are received from the RCA
- based on T-4 income with no salary cap
- no rigid schedule for contributions or withdrawals
- carve out profit before dividending out to HoldCo.
- perpetual trusts, not subject to the 21-year rule
- excellent for inter-generational transfer of wealth
The 800 Pound Gorilla of Retirement Plans for Business Owners
Taking this strategy a step further, you can fund your RCA with a permanent key-man insurance policy to create an insured RCA Trust, which will give you the strongest creditor protection possible.
The RCA has an investment account (RIA) and a tax account (RTA). When the investment account is funded using an exempt insurance policy, investment earnings are allowed to grow tax free in the exempt policy. The resulting insured RCA trust is the undisputed 800 Pound Gorilla of Retirement Plans for Business Owners.
An insured RCA trust is the undisputed 800 Pound Gorilla of Retirement Plans for Business Owners.
Perhaps most importantly, if you run a medium size business in Canada, there is a possibility that you may, at some point in the future, be the target of litigation. It is not enough to simply segregate funds for retirement in your OpCo or HoldCo, which can be attacked. An insured RCA trust can be used to create creditor protected assets, in the event of an attack or insolvency, moving your retirement assets beyond the reach of your creditors.
Business Succession Planning
A common misunderstanding is that, when it comes time to sell your business, the sale will occur pursuant to a share purchase transaction or acquisition, which would allow the favorable tax treatment of the proceeds involving the use of lifetime capital gains allowance and splitting with family members.
This is usually not the case. Most transactions of this nature are completed pursuant to an asset purchase/sale agreement, which is much more favorable from a tax perspective to the acquiring entity.
The cold hard reality is that, upon sale of your business, you will likely end up actually selling the assets, leaving you with a shell company full of cash. While that may sound good, the sad truth is that such a transaction will result in income generated in the company, and will be taxed accordingly. To add insult to injury, when that cash is pulled out of the company, it will be taxed at the highest marginal tax rate.
Accountants typically advise their clients to bonus out the proceeds of the sale and pay the tax. The result will be a punitive personal income tax and health care tax..
You can address this using a Retirement Compensation Arrangement, which can dramatically reduce your overall tax hit associated with the sale of the assets. When it comes time to execute the buyout, you can simply contribute most of the proceeds of the transaction to the RCA, and defer any tax.
So an insurance funded RCA can provide an excellent mechanism to facilitate a buyout or management buyout.
The traditional criticism of Retirement Compensation Arrangements has been that 50% of contributions must be remitted to Canada Revenue Agency as a refundable tax, which is held by CRA and returns 0% interest.
Retirement Compensation Arrangements (RCAs) are back with a vengeance and accountants are starting to take notice.
Because of ultra-low prevailing interest rates, and high marginal tax rates, this argument makes no sense. It is better to pay 50% into a refundable tax account and benefit from the tax exempt accrual of investment gains, since you will receive a chunk of that refundable tax back at a later date.
Business owners and key executives of a Canadian Controlled Private Corporation (CCPC) making in excess of the small business limit will qualify. First you’ll need an actuarial calculation of your pension entitlement, and obtain an illustration, using your own data, to see how well the strategy would work for you. The process should include consultation with your Lawyer, CFO Accountant and/or trusted advisor, before you proceed.
A major caveat is that “the face amount of the policy must not be excessive, so as not to trigger an advantage under CRA guidelines.” Roy Craik, founder of Retirement Compensation Funding Inc.
In this day and age, it may make sense to ruggedize your retirement strategy with an Insured RCA Trust – The 800 Pound Gorilla of Retirement Plans for Business Owners.
E. & O. E.